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Public Finance Solved Question Papers: Nov' 2019 | Dibrugarh University | B.Com 5th Sem

 2019 (November)

COMMERCE (General / Speciality)

Course: 501 (PUBLIC FINANCE)

The figures in the margin indicate full marks for the questions

(New Course)

Full Marks: 80

Pass Marks: 24

Time: 3 hours

 

1. Answer the following questions:                          1x8=8

a) What do you mean by public finance?

Ans: Public finance is a study of income and expenditure or receipt and payment of government. It deals the income raised through revenue and expenditure spend on the activities of the community and the terms ‘finance’ is money resource i.e. coins.

b) Who developed the theory of ‘principle of maximum social advantage’?

Ans: Professor Hugh Dalton

c) What is budgetary control?

Ans: Budgeting control is the process of determining various budgeting figures for the enterprises for the further period and then comparing the budgeted figures with the actual performance for calculating variances.

d) Write the full form of ZBB.

Ans: ZERO BASED BUDGETING

e) Mention one distinction between tax and fees.

Ans: Tax is compulsory payment to the government but fees are not compulsory.

f) What is public revenue?

Ans: A government needs income for the performance of a variety of functions and meeting its expenditure. Thus, the income of the government through all sources like taxes, borrowings, fees, and donations etc. is called public revenue or public income.

g) Mention any one distinction between public expenditure and private expenditure.

Ans: The motive of public expenditure is the welfare of the public whereas the motive of private expenditure is purely personal welfare.

h) What is deficit financing?

Ans: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.

2. Write short notes on:                4x4=16

a) Public and Private Finance.

Ans: Generally, the word ‘finance’ is loosely used for both the public and private finance. By private finance, we mean the study of the income, debt and expenditure of an individual or a private company or business venture. On the other hand public finance deals with income, expenditure and borrowings of the government. There are both similarities and dissimilarities in governmental financial operations as compared to the monetary operations of private businessman. An individual is interested in the utilisation of labour and capital at his disposal to satisfy social wants. In short, both private finance and public finance have almost the same objective of satisfaction of human wants. Again, private finance stresses individual gains whereas public finance attempts at promoting social welfare of the whole community. These two view points are correct to greater extent only because of their similarities as well as dissimilarities between both.

Similarities between Public and Private Finance

1.       Both the State as well as individual aim at the satisfaction of human wants through their financial operations. The individuals spend their income to satisfy their personal wants whereas the state spends for the satisfaction of communal or social wants.

2.       Both the States and Individual at times have to depend on borrowing, when their expenditures are greater than incomes.

3.       Both Public Finance and Private Finance have income and expenditure. The ultimate aim of both is to balance their income and expenditure.

4.       For both kinds of finances, the guiding principle is rationality. Rationality is in the sense that maximization of personal benefits and social benefits through corresponding expenditure.

5.       Both are concerned with the problem of economic choice, that is, they try to satisfy unlimited ends with scarce resources having alternative uses.

b) Performance Budget.

Ans: Performance budgeting is generally understood as a system or technique of presentation of public expenditure in terms of functions, programmes, performance units, i.e. activities, projects etc, reflecting primarily the government output and its cost. The focus in a performance budgeting is basically different from that in the conventional budgets. The two approaches differ in their scope and context. Under the performance budgeting, emphasis is shifted from the budget as a means of accomplishment to the accomplishment itself. If concerns itself primarily with the objectives aimed at by the government rather than with the outlays incurred on several projects. According to U. S. Bureau of Budget, “A performance is one which presents the purpose the objectives for which funds are required, the cost of the programmes proposed for achieving those objectives and quantitative data measuring the accomplishment and work performed under each programme.”

Under performance budgeting system, the overall budget is divided into functions based on the major purpose of government and then subdivided into programme and activities, funds being granted for doing a specific quantity of work. Performance budgeting implies that the budget statement should indicate the actual achievements expected by a Ministry over a period of time from certain amount of expenditure. It forces attention on the size and cost of programme to be implemented.

c) Taxable Capacity.

Ans: Taxable capacity refers to the maximum capacity that a country can contribute by way of taxation both in the ordinary and extraordinary circumstances. It represents maximum limit to which the government can tax the people of the country. If the government exceeds this limit, it shall result in over taxation, which, besides being injurious to the long-term interests of the community, may pose a serious threat, to the political stability of the country concerned. The concept of taxable capacity, thus, indicates the limit to which the government can tax the citizens.

Taxation Inquiry Commission defined it as, Taxation capacity of different sections of the community may be said to refer to the degree of taxation, broadly speaking, beyond which productive effort and efficiency as a whole begin to suffer. The concept of taxable capacity has been interpreted by the economists in the following two senses: (i) the absolute taxable capacity of one single community, and (ii) the relative taxable capacity of two or more communities.

d) Scope of Public Expenditure.

Ans: Public Expenditure refers to Government Expenditure for maintenance of the government and to preserve the welfare of society as a whole. It is incurred by Central and State Governments or local authorities. The Public Expenditure is incurred on various activities for the welfare of the people and also for the economic development, especially in developing countries. In other words The Expenditure incurred by Public authorities like Central, State and local governments to satisfy the collective social wants of the people is known as public expenditure.

Public expenditure shows the decisions of the parliament and other independent executive bodies for the scope of public expenses. It is measured with respect to the public expenses made by the government in the previous year or last financial interval. Public expenditure are classified into two parts: current expenditure and capital expenditure.

In the present world, public expenditure is very important due to the following two reasons:

a) The economic activities of the government have increased manifold.

b) The nature and volume of public expenditure have important effects on production, distribution and the general level of economic activity.

Therefore, it is the need of the hour that state should participate in almost every field and the government is responsible even for small matters. Some writers advocated that public expenditure should be forced to deal with many day-to-day activities like re-allocation of resources, redistribution activities, stabilizing activities and commercial activities.

3. (a) State about the importance of public finance in modern times. Also discuss the role of public finance as a tool of economic and social welfare.      7+7=14

Ans: Importance (Significance) of Public Finance

There is great socio-economic significance of public finance, both in developed and developing countries. In developed country countries, price-stability and full employment are the main economic goals of public finance. In developing countries, rapid economic development through capital formulation and creation of infrastructure art the important goals of public finance operations. Socially equitable distributions of income, reduction of inequalities in income are some important functions of public finance operations. The importance of public finance can be clarified from the following functions.

1. TO INCREASE THE RATE OF SAVING AND INVESTMENT: Most of the people spend their income on consumption. Saving is very low so the investment is also low. The government can encourage the saving and investment.

2. TO SECURE EQUAL DISTRIBUTION OF INCOME AND WEALTH: Unequal distribution of income and wealth is the basic problem of the under developed countries. The rich are getting richer and richer while the poor are becoming poorer and poorer. So for the equal distribution of income and wealth there is need of government.

3. OPTIMUM ALLOCATION OF RESOURCES: Fiscal measures like taxation and public expenditure programmers can greatly affect the allocation of resources in various occupation and sectors.

4. CAPITAL FORMULATION AND GROWTH: Fiscal policy will be designed in a manner to perform two functions as of expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels.

5. PROMOTING ECONOMIC DEVELOPMENT: The state can play a prominent role in promoting economic development especially through control and regulation of economic activities. It is fiscal policy which can promote economic development.

6. IMPLEMENTATION OF PLANNING: Under democratic planning fiscal policy plays crucial role as financial plan is as much important as physical plan and the implementation of the financial will obviously depend upon the uses of fiscal measures.

7. INFRASTRUCTURE BUILDING: Public finance helps to build up well-development physical and institutional infrastructure.

Role of public finance in an underdeveloped country like India

Public Finance occupies great significance in an underdeveloped or developing country. According to R. J. Chelliah, “Public finance has a positive and significant role in the context of economic development.” The importance of public finance in an underdeveloped/developing country like India may be summarized as under:

a)      Capital Formation: Since development entirely depends on the rate of capital formation in the country, the first and foremost aim of public finance is to promote capital formation. Students of commerce and economics are well aware of the fact that the burning problem of an underdeveloped or developing country is the low capital formation. In the words of Dr. Baljit Singh, “For an undeveloped country all economic policies and measures in the initial stages must concentrate on production and fiscal policy should act as a tool of capital formation.” Capital formation can be increased through an effective and well-planned taxation policy. In the words of R. Nurkse, “For economic development, it is not the aim of public finance to bring about reduction in inequalities of incomes but its aim is to increase that proportion of the income which goes into capital formation.”

b)      Unemployment Problem: Another major problem of an underdeveloped/developing country is the unemployment problem. Increased income may be eaten up by a large mass of unemployed people. This problem of unemployment leads again to low standard of living, poverty, backwardness, ignorance and above all starvation. It is the function of public finance to provide employment opportunity. In the connection must be remembered that fiscal policies (public finance policies) are most effective tools for tackling of the problem of unemployment.

c)       Planned Economic Development: In underdeveloped/developing countries the productive resources are limited in quantity as well as quality. Public finance renders valuable help in the planned economic development of the country. The entire machinery of planning works through the mechanism of public finance. The principles of public finance have paramount importance in the sphere of rapid economic planning because both of these are the closely related activities of the state. For example, the Government of India is raising necessary funds through taxation etc. for formulation and implementation of its five year plans.

d)      Increase in Income: Capital formation is not an end in itself but only a means of achieving another important end, i.e. increase in income. The object of public expenditure is to increase the income in underdeveloped countries so at to invest funds in such industries and in such an economical and efficient manner that least amount of money fetches the greatest possible output. The Government gives subsidies and grants to industries to enable them to increase production at cheaper rates. This will lead to prosperity and development with an overall increase in the income of the masses.

e)      Reduction in Economic Inequalities: Another problem of underdeveloped or developing countries is the unequal distribution of income and wealth to the public. Public finance has an important role to play in this context. For example, the Government can impose heavy taxes (such as income tax) on the richer sections of the society and spend the income so received on providing cheap food, cheap housing, employment, free medical aid etc. for poorer sections of the society.

f)       Optimum Utilization of Resources: Another major problem of underdeveloped or developing countries is the problem of non-utilization or even destruction of the scarce and limited resources. The solution of this basic problem lies in the optimum utilization of these available resources by means of adopting planned monetary and public finance policies. The state can direct the flow of consumption, production and distribution in the right direction by adopting balanced budget policy.

g)      Problem of Economic Stabilization: Another problem of an underdeveloped and developing country is the economic instability. After 1929-30 worldwide depression, it has been emphasised that public finance (revenue and expenditure process of the Government) may be used to secure economic stability or to remove economic fluctuations and distortion in the economy.

h)      Increase to Savings: The major problem of developing and underdeveloped countries is that savings are very nominal which hinder their economic development. Public finance encourages the accumulation of savings.

Or

(b) Critically explain the theory of ‘principle of maximum social advantage’.   14

Ans: THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE

One of the important principles of public finance is the so – called Principle of Maximum Social Advantage explained by Professor Hugh Dalton. Just like an individual seeks to maximize his satisfaction or welfare by the use of his resources, the state ought to maximize social advantage or benefit from the resources at its command.

The principles of maximum social advantage are applied to determine whether the tax or the expenditure has proved to be of the optimum benefit. Hence, the principle is called the principle of public finance. According to Dalton, “This (Principle) lies at the very root of public finance” He again says “The best system of public finance is that which secures the maximum social advantage from the operations which it conducts.” It may be also called the principle of maximum social benefit. A.C. Pigou has called it the principle of maximum aggregate welfare.

Public expenditure creates utility for those people on whom the amount is spent. When the volume of expenditure is small with a slighter increase in it, the additional utility is very high. As the total public expenditure goes on increasing in course of time, the law of diminishing marginal utility operates. People derive less of satisfaction from additional unit of public expenditure as the government spends more and more. That is, after a stage, every increase in public expenditure creates less and less benefit for the people. Taxation, on the other hand, imposes burden on the people.

So, when the volume of taxation becomes high, every further increase in taxation increases the burden of it more and more. People under go greater scarifies for every additional unit of taxation. The best policy of the government is to balance both sides of fiscal operations by comparing “the burden of tax” and “the benefits of public expenditure”. The State should balance the social burden of taxation and social benefits of Public expenditure in order to have maximum social advantage.

Attainment of maximum social advantage requires that;

a) Both public expenditure and taxation should be carried out up to certain limits and no more.

b) Public expenditure should be utilized among the various uses in an optimum manner, and

c) The different sources of taxation should be so tapped that the aggregate scarifies entailed is the minimum.

Assumptions of this theory:

1.All taxes result in sacrifice and all public expenditures lead to benefit.

2. Public revenue consists of only taxes and there is no other source of income to the government.

3. The govt. has no surplus or deficit budget but only a balanced budget. 

Diagrammatical Explanation of the theory of maximum social advantages


In the above diagram, MSS is the marginal social sacrifice curve sloping upward from left to right. This rising curve indicates that the marginal social sacrifice goes on increasing with every additional dose of taxation.   MSB is the marginal social benefit curve sloping downwards from the left to right. This falling curve indicates that the marginal social benefit diminishes with every additional dose of public expenditure. The two curves MSS and MSB intersect each other at the point P. PM represent both marginal social sacrifice as well as marginal social benefit. Both are equal at OM which represents the maximum social advantage.

Criticism of the theory of Maximum Social Advantages

1. Non measurability of social sacrifice and social benefit: The major drawback of this principle is that it is not possible in actual practice to measure the MSS and MSB involved in the fiscal operation of the state.

2. Non applicability of the low of equimarginal utility in public expenditure: The low of equimarginal utility may be applicable to private expenditure but certainly not to public expenditure.

3. Neglect non-tax revenue: The principle says that the entire public expenditure is financed by taxation. But, in practice, a significant portion of public expenditure is also financed by other sources like public borrowing, profits from public sector enterprises, imposition of fees, penalties etc.

4. Lack of divisibility: The marginal benefit from public expenditure and marginal sacrifice from taxation can be equated only when public expenditure and taxation are divided into smaller units. But this is not possible practically.

5. Assumption of static condition: Conditions in an economy are not static and are continuously changing. What might be considered as the point of maximum social advantage under some conditions may not be so under some other.

6. Misuse of government funds: The principle of Maximum social advantage is based on the assumption that the government funds are utilized in the most effective manner to generate marginal social benefit. However, quite often a large share of government funds is misused for unproductive purposes

7. "The govt. has no surplus or deficit budget but only a balanced budget."- is an invalid assumption.

4. (a) Define financial administration. Discuss about the aims and objectives of financial administration.    4+5+5=14

Ans: Meaning of Financial Administration

In simple words, financial refers to such a system or method by which one can analyse the financial working of the public authority. Thus the focuses on the procedure which ensure the lawful use of public funds. However the concept has been differently defined as under:

Prof .M.S Kenderic, “The financial administration refers to the financial measurement of govt. including the preparation of budget method of administering the various revenue resources the custody of the public fund, procedures in expending money, keeping the financial records and the like. These functions are important to the effective conduct of operation of public finance”

Prof. Dimock, “Financial administration consists of a series of steps whereby funds and made available certain official under procedures which will ensure their lawful and efficient use. The main ingredients are budgeting, accounting, auditing and purchase and supply.”

Aim of Financial Administration:

1. To collect, preserve and distribute various revenue collected from various sources of revenue.

2. To maintain coordination between public revenue and public expenditure.

3. To collect and manage public loans which are collected for various development projects.

4. To run the public enterprises efficiently and make proper arrangement of funds needed in public enterprises.

5. To provide maximum benefit to the public by incurring government expenditure through right hands at the right time and at the right place.

Need and Importance of Financial Administration:

Finance is the life blood of all economic activities. Finance is the fuel of administrative machinery. Just as fuel is required for the operation of a machine, similarly efficient financial administration is essential for the success of administration. The need and importance of financial administration may be studied under the following heads:

1. Maximum advantage to public from public expenditure: The main objective of government finance is to benefit the public to the maximum. It is possible only when the government expenditure is incurred through right hands at the right time and at the right place. It all depends on the efficiency of the government financial administration.

2. Less incidence of taxation on public: It is an open secret that the public wants to have minimum incidence of taxation. If the amount of taxation is increased beyond its optimum limits the process of taxation will become complex on one side and cause dissatisfaction as well as opposition by the public on the other side. From this point of view also it is essential to adopt an effective and sound financial administration policy.

3. Management of Public Loan: Public loan occupies an important place in the present public finance procedure. Government takes public loans for financing the development projects. Now for the proper utilisation of public loans and repayment along with interest on due dates, an efficient financial administration is called for.

4. Efficient operation of public enterprises: Gone are the days when lasses faire policy propounded by the classical economists dominated the economic and political scene of the world. Now the government is require to perform several economic functions also. Operation of public enterprises is also an important function of the modern government. It requires an efficient and effective financial administration.

Besides the above, in a democratic setup the government is required to fulfill the responsibility of public accountability, establishment of a welfare state, providing incentives to capital formation, conducting economic planning successfully and proper utilisation of limited available financial resources of the country. Thus, the financial administration is required to play an important role. That is why, financial administration is considered an important subject in the economic, social and political life of a country.

Or

(b) What do you mean by zero-base budgeting? Discuss about its need and preconditions.    2+4+8=14

Ans: Zero Based Budgeting

Zero Base Budgeting is a new technique for the preparation of budgets. It involves fresh evaluation of every item of expenditure as if it were a new item. It is reconsideration of each item of expenditure from the very beginning. It is like assuming that zero expenditure has been incurred on a project at the time of its review, although the project may be in existence from a long time and may have involved some expenditure also. The review is meant to provide a justification or otherwise of the project as a whole in the light of objectives set for it and priorities of the society. The procedure is altogether different from the usual procedure followed in India.

Peter A. Phyrr describes, the concept of zero base budgeting as an operating, planning and budgeting process that requires each manager to justify a budget request in detail from scratch…….” It means, the budget as a whole is considered rather than to examine incremental change only.

According to Prof. R. A. Musgrave, “the idea of zero base budgeting is to consider the budget as a whole, rather than to examine incremental changes only.”

Essentially, the concept of zero base budgeting is that all the financial requirements of a budget unit are analyzed, evaluated and justifies annually and not just the increased or additional requirements. In more practical way, zero base budgeting means the evaluation and prioritization of all programmes at different levels of effects. To be simpler, under zero base budgeting, each department ministry is required to justify its budget requests from the bottom up, evaluating alternative programme packages and ranking programmes so as to select the best alternative and allocate resources accordingly. The budget is considered as a whole and a fresh one, i.e. from zero base.

Need of ZBB

Zero-base budgeting is revolutionary concept and is relatively a new management tool for planning and control of activities. It involves people at all levels in the organization and promotes team spirit. The plans and budgets based upon ZBB are much improved than shoes based upon traditional budgeting. There are a number of benefits that arise from zero-base budgeting. Some of the important needs of ZBB are enumerated below:

1.       Proper Allocation of Funds: It enables management to allocate funds according to the jurisdictions of the programme. The priority can be fixed for various activities and their implementation will be in the same order.

2.       It improves Efficiency: Zero-base budgeting improves efficiency of the management. Every manager will have to justify the demand for resources. Only those activities will be undertaken which will have justification and will be essential for the business.

3.       Identification of Economical Areas: Zero-base budgeting will help in identifying economical and wasteful areas. Emphasis will be given to economical activities and alternative courses of action will also be studies.

4.       Optimum use of Resources: The management will be able to make optimum use of resources. The expenditures will be undertaken only when it will have justification. A list of priorities is prepared and cost-benefit analysis will be the guiding principle in fixing the priority.

5.       Determining of Utility: Zero-base budgeting will be appropriate for those areas whose output is not related to production. It becomes difficult to evaluate the performance of those sides which are not directly related to production but undertaken other activities. This technique will be helpful in determining the utility of each and every activity of the business.

6.       Useful of Attain organizational Goals: Budgeting will be related to organizational goals. Something will not be allowed the plea that it was done in the past. Only those things will be allowed which will help in realizing organizational goals.

PRE-CONDITIONS OF ZERO BASED BUDGETING (ZBB)

The introduction of Zero Base Budgeting (ZBB) is not as easy as it appears. It requires a tremendous paper-work and detailed analysis. Thus, the organization should be able to provide all information including the cost data necessary for introducing ZBB. Moreover, the successful implementation of the zero base budgeting also depends upon the availability acceptability of the concept in letter and spirit. Obviously, this acceptance would be associated with the organization where the new system has to be implemented. It is so because any apathy on the part of the people could lead to a situation in which priorities relating to the existing schemes may not be assessed accurately. In short, it requires the following pre-conditions:

1. Committed Management: The top management must be committed as well as have a participatory role.

2. Fixed goals: Organisational goals must be fixed. As ZBB is not an end product itself but a means to achieve targets, goal setting must not be vague and ambiguous.

3. Identification of weakness: Weakness of an organisation must be perceived and strengths enumerated so that identified weak areas can be worked upon.

4. Trained staff: ZBB requires staff to be trained for its procedures to be implemented properly.

5. Elimination of doubts: All levels of management must cooperate with each other by eliminating all doubts regarding the ZBB procedure.

6. Review: Decision packages must be reviewed periodically.

7. Brainstorming Session: There must be brainstorming sessions at all hierarchical levels to get proper and timely feedback.

 

5. (a) What are the different sources of public revenue? Discuss the effects of public revenue on the following:    5+9=14

1) Revenue (direct and indirect)

2) Tax distribution.

3) Present and future generation.

Ans: In a modern welfare state, public revenue is of two types:

(a)    Tax revenue and

(b)   Non-tax revenue.

(a) Tax Revenue: A fund raised through the various taxes is referred to as tax revenue. Taxes are compulsory contributions imposed by the government on its citizens to meet its general expenses incurred for the common good, without any corresponding benefits to the tax payer. Seligman defines a tax thus: “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to specific benefits conferred.

Examples of Tax Revenue 

Ø  Income Tax(on income of the individual as well as joint Hindu families) 

Ø  Corporation Tax (on income of the companies both domestic and foreign companies operating in India ) 

Ø  Interest Tax (on the gross interest income of the financial institutions like Bank) 

Ø  Expenditure Tax(expenditure incurred in luxury hotels and restaurants) 

Ø  Wealth Tax(total wealth of individuals and Hindu undivided families) 

Ø  Custom Duty.(import and export duty) 

Ø  Central excusive Duty.(duties on industrial products) 

Ø  Service Tax.(on services provided by hotels, telephones, port services etc.) 

(b) Non Tax Revenue: The revenue obtained by the government from sources other than tax is called Non-Tax Revenue. The sources of non-tax revenue are:

1. Fees: Fees are another important source of revenue for the government. A fee is charged by public authorities for rendering a service to the citizens. The government provides certain services and charges certain fees for them. For example, fees are charged for issuing of passports, driving licenses, etc.

2. Fines or Penalties: Fines or penalties are imposed as a form of punishment for breach of law or non fulfillment or certain conditions or for failure to observe some regulations. Like taxes, fines are compulsory payments without quid pro quo. But while taxes are generally imposed to collect revenue. Fines are imposed as a form of punishment or to prevent people from breaking the law.

3. Surplus from Public Enterprises: The Government also gets revenue by way of surplus from public enterprises. In India, the Government has set up several public sector enterprises to provide public goods and services. Some of the public sector enterprises do make a good amount of profits. The profits or dividends which the government gets can be utilized for public expenditure.

4. Special assessment of betterment levy: It is a kind of special charge levied on certain members of the community who are beneficiaries of certain government activities or public projects. For example, due to a public park in a locality or due to the construction of a road, people in that locality may experience an appreciation in the value of their property or land. Thus, due to public expenditure, some people may experience 'unearned increments' in their asset holding.

5. Grants and Gifts: Gifts are Voluntary contributions by individuals or institutions to the government. Gifts are significant source of revenue during war and emergency. A grant from one government to another is an important source of revenue in the modern days. The government at the Centre provides grants to State governments and the State governments provide grants to the local government to carry out their functions.

6. Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.

FFECTS OF PUBLIC REVENUE

The effects of public revenue can be discussed under the following heads as:

1. Effects of Revenue-Direct and Indirect: For the consideration of effects of public revenue on social welfare it is best to suppose that revenue is raised and then destroyed. That would enable us to ignore effects that the knowledge and expectation of public expenditure has the minds of the tax payers. When a tax is levied on an individual his income decreases. If pays out of his income, then it is directly and immediately reduced. He decides to pay it out of his savings and current income is not used but future income derived from his saving decreases. In any case the effect of taxation is thus to reduce the income of people. This accounts for the sacrifice of taxation. We may study effects of direct reduction of income and indirect reduction of it.

The immediate decrease of income takes place, as we have when the tax payer pays tax out of his current consumable income when that happens he is force to cut down his present consumption of goods and services. If he consumes less of luxuries, the adverse effect of taxation occurs. But if he cuts down his consumption of necessaries more than luxuries the effects are more pronounced.

2. Effects of Present and Future Generation: This brings us to the consideration of the effects of taxation on the present and future generation. When taxes are paid out of current consumable the present generation directly and immediately suffers. However, they are affected in two ways. First, the reduction of consumer goods may decrease the efficiency of the people and thereby the amount of wealth they can produce and save for succeeding generation. But they also such effects will be partly or wholly offset by expenditure policy of the govt. But the payment of taxes will themselves have the effect of shifting the incidence of sacrifice on future generation to some extent. In the second place, they may suffer due to adverse effects on production caused by increased demand for consumption goods.

3. Effects on Tax Distribution: The effects of taxes do not only differ according to the aggregate volume of revenue raised or according to its impact on current consumable income and savings; they also depend on the distribution of the tax burden between the tax payers. Taxes not levied equally on all. They are so levied as to minimize the sacrifice. Thus some have to pay more than others. If the Govt. is successful in so fixing the rates of taxes as to minimize sacrifice jointly made by the tax payers, we have to consider only effects of taxation on the people in the manner that we have done. But the government is not likely to succeed in minimizing the aggregate sacrifice.

Or

(b) What do you mean by ‘canons of taxation’? State and explain Adam Smith’s canons of taxation. 2+12=14

Ans: CANONS OF TAXATION

In the modern age, tax is the main source of Income. Every tax is an additional burden on the tax-payer. Thus, it is essential that the burden of a tax should be divided in equitable manner. Every govt. bears the responsibility to provide certain facilities to its subject. For this purpose, the govt. has to adopt a definite principle. Further, it needs definite machinery for imposing, collecting and utilizing the money. Therefore, a better taxation system speaks of the better taxing capacity and efficient economic administration of the governments.

It is an important question as to how the taxes can be levied and what should be pattern of distribution of the taxes. Moreover, taxation does not have only economic but also social and political implications. For every new tax, it is correct to note the ‘motive’ behind such proposals. In short, it carries the motives of capacity to pay, no discrimination and positive effect on the balance of payment.

However, these motives cannot be achieved unless a clear cut policy regarding the imposition of taxation is followed. Economists have suggested various principles regarding taxation. But none of had given the exact canons of taxation. The canons or principles given from time to time bear the testimony of a good taxation policy.

ADAM SMITH’S CANNONS TAXATION

Adam Smith was the first writer to give a detailed and comprehensive statement of the principles of taxation. Basically, he laid stress on the ways in which an economy could increase its productive capacity and ultimately achieve a higher rate of economic growth. According to him, if the principles enunciated by him, were adopted in a full spirit, the govt. would have a very sound taxation policy. Findlay Shirras has strongly commented on the contribution made by Adam Smith, “No genius, however, has succeeded in condensing the principles into such clear and simple canons as has Adam Smith.” Adam Smith has enumerated the following four canons of taxation which are accepted universally:

1)      Canon of Equality.

2)      Canon of Certainty.

3)      Canon of Convenience.

4)      Canon of Economy.

1)      Canon of Equality: According to this canon, a good tax is that which is based on the principle of equality. In a broader sense, equality may be considered to be same as justice. In this principle, it is maintained that the tax must be levied according to the taxpaying capacity of the individuals. Adam Smith had defined this principle as follows: “The subject of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities that is , in proportion to the revenue which they respectively enjoy under the protection of states.”

In other words, the principle of benefit states that the burden of taxation should be fair and just. Thus, rich people must be subjected to higher taxation in comparison to poor. The higher the income and higher the tax, the lower the income of lower the tax.

2)      Canon of Certainty: Another canon of taxation is the certainty which implies that the tax-payer should determine the following manners carefully: (a) The time of payment, (b) Amount to be paid, (c) Method of payment, (d) The place of payment, (e) The authority to whom the tax is to be paid.

With this, a tax-payer will be able to keep equilibrium between his income and expenditure. There should not be any embarrassment and confusion about the payment of tax. Every tax-payer must know the time of payment, manner and mode of payment, so that he may adjust his expenditures accordingly. In the words of Adam Smith, “The tax which each individual is bound to pay ought to be certain the not arbitrary. The time of payment, the manner of payment, the quantity to be paid, all ought to be clear and plain to the contributor and to every other person.” This certainty creates confidence in the contributor of the tax.

3)      Canon of Convenience: The taxes should be levied and collect in such a manner that it provides the maximum of convenience to the tax-payers. The public authorities should always keep this point in view that the tax-payers suffer the least inconvenience in payment of the tax. For example, land revenue should best be collected at the harvest time. The income-tax from the salaried class be collected only when they get their salaries from their employers. To quote Adam Smith, “Every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it.” This canon is important both for the tax-payers and the govt. The tax-payer feel convenient in payment of tax. The authorities also come to know the incidence of taxation and get increased income by way of taxes.

4)      Canon of Economy: It implies that minimum possible money should be spent in the collection of taxes. The maximum part of the collected amount should be deposited in the govt. treasury. Thus, all unnecessary expenditure in the collection should be avoided at all costs. In the words of Adam Smith, “Every tax ought o be so contrived as little to take out and to keep out of the pockets of the people as possible over and above what is brings into public treasury of the state.” So more addition should be secured to the public revenue at the minimum maintenance cost. It also implies that a tax should interfere as little as possible with the productive activity and general efficiency of the community so that it may not create any adverse effect on production and employment.

 

6. (a) “Public expenditures has a tendency to grow very fast in modern times.” Briefly discuss the factors responsible for the rapid growth of public expenditure.                   14

Ans: Causes for increase in Public Expenditure

There has been a persistent and continuous increase in public expenditure in counties all over the world. It is due to the continuous expansion in the activities of the state and other public bodies on several fronts. The modern governments not only perform such primary functions as the civil administration as well as defence of the country, but also take considerable interest in promoting economic development of their countries. Today, the state is taking active part in social and economic matters, such as education, public health, removal of poverty and in commercial and industrial development. The public expenditure has increased enormously in recent years mostly due to the development activities of the state. Hence, the increase in public expenditure is fully justified.

FACTORS OR CAUSES OF INCREASE IN PUBLIC EXPENDITURE

One of the most important features of the present century is the phenomenal growth of public expenditure. Some of the important reasons for the growth of public expenditure are the following.

1) Welfare state: Modern states are no more police states. They have to look in to the welfare of the masses for which the state has to perform a number of functions. They have to create and undertake employment opportunities, social security measures and other welfare activities. All these require enormous expenditure.

2) Defence expenditure: Modern warfare is very expensive. Wars and possibilities of wars have forced the nation to be always equipped with arms. This causes great amount of public expenditure.

3) Growth of democracy: The form of democratic government is highly expensive. The conduct of elections, maintenance of democratic institutions like legislatures etc. cause great expenditure.

4) Growth of population: tremendous growth of population necessitates enormous spending on the part of the modern governments. For meeting the needs of the growing population more educational institutions, food materials, hospitals, roads and other amenities of life are to be provided.

5) Rise in price level: Rises in prices have considerably enhanced public expenditure in recent years. Higher prices mean higher spending on the part of the govt. on items like payment of salaries, purchase of goods and services and so on.

6) Expansion public sector: Counties aiming at socialistic pattern of society have to give more importance to public sector. Consequent development of public sector enhances public expenditure.

7) Development expenditure: for implementing developmental programs like Five Year Plans, Modern governments are incurring huge expenditure.

8) Public debt: Along with debt rises the problem like payment of interest and repayment of the principal amount. This results in an increase in public expenditure.

9) Grants and loans to state governments and UTs: It is an important feature of public expenditure of the central government of India. The government provides assistance in the forms of grants-in-aid and loans to the states and to the UTs.

10) Poverty alleviation programs: As poverty ratio is high, huge amount of expenditure is required for implementing alleviation programmes.

Justification for increase in Public Expenditure

Increase in public expenditure can be justified on the following grounds:

a)      Assists in increasing state activities,

b)      Increase in welfare activities,

c)       Reduces disparities between rich and poor,

d)      Boom for rapid economic development specially in underdeveloped and backward economy,

e)      Provides economic stability, and

f)       Brings prosperity etc.

Or

(b) Explain the effects of public expenditure on production and distribution.                 7+7=14

Ans: Effects of Public Expenditure

Public expenditure incurred according to the sound principles of public finance, exerts healthy effects on the entire economy of a nation. The ultimate effects of public expenditure, in the form of greater production, more equitable distribution of wealth and all-round economic development of a country, are always expected to be present, if the expenditure is incurred after considerable thought and utmost rationality.

Gone are the days when it was advocated that the state should interfere the least in economic activities and the government is merely an agent for the people – responsible for the maintenance of justice, police and army. In those days public expenditure on economic activities was normally considered a waste. Contrary to this, a new concept of public expenditure has been developed by the modern economists. Today, public expenditure is regarded as a means of securing social ends rather than just being a mere financial mechanism. In present times, Wagner’s Law of Increasing Public Expenditure – both extensively and intensively, is considered universally true. The trend of rising public expenditure is not confined to any particular country, but it is found in almost all countries of the world, irrespective of its socio-economic and political set-up. Every public expenditure is considered desirable, when it is not wasteful, but has a positive effect on production, distribution, consumption and thus maximizes economic and social welfare of the country as a whole.

Effects of public expenditure can be studied under the following heads:

a)      Effects of Public Expenditure on Production.

b)      Effects of Public Expenditure on Distribution.

c)       Miscellaneous Effects of Public Expenditure including Consumption.

Effects of Public Expenditure on Production: While analyzing the effects of public expenditure, Dalton very correctly said that just as taxation, other things being equal should reduce production as little as possible, so the public expenditure should increase it as much as possible. He further added that the level of production and employment in any country depends upon the following three factors:

1)      Effects upon the Ability to Work, Save and Invest: If public expenditure increases the efficiency of a person to work, It will promote production and national income. Public expenditure on education, medical services, cheap housing facilities, means of transport and communications, recreation facilities etc. will increase the efficiency of persons to work. At the same time, public expenditure can promote saving on the part of the lower income groups by providing additional income to them, for a person who has larger income can be normally expected to save a larger amount. Finally, public expenditure, particularly repayment of public debt will place additional funds at the disposal of those who can save. Thus, it is evident that public expenditure can promote ability to work, save and invest and thus promote production and employment.

2)      Effects on Willingness to Work, Save and Invest: Public expenditure also affects the people’s willingness to work, save and invest. Pension, provident fund, interest-free loan, free medical aid, unemployment allowances and other government payments provide security to a person and, therefore, reduce the willingness of persons to work and save – after all, why should a person work hard and save when he knows fully he will be looked after by the government when he is not in a position to earn any income, i.e. he finds his future fully secured. In the absence of any savings, the question of investment does not arise at all.

3)      Effects on Diversion of Resources: Public expenditure also affects the diversion of resources. For example, if the government wishes to attract productive resources to a particular industry, it will start giving financial assistance from its own funds to such an industry. In the same way, if the government wishes to attract productive resources to a particular area or region, it will start giving a variety of incentives in the form of bounties, subsidies etc. (such as land at concessional rates, cheap electric supply and water, loans on nominal rates of interest, freedom from sales tax, income-tax etc. for a certain period, production subsidy etc.) to the industrialists to achieve this objective.

Effects of Public Expenditure on distribution: Public expenditure has its effects not only on production but is also a most powerful weapon in the hands of the government for bringing about an equitable distribution of wealth. For bringing about an equitable and just distribution of wealth the government can use not only its taxation policy but public expenditure policy can also help to a great extent in achieving this very objective. In fact, the role of taxation and public expenditure in removing inequalities of income is complementary and supplementary. If the government intends to minimize the economic inequalities that existed in the society, it should levy maximum about of taxation on richer sections of the community, because their taxable capacity is undoubtedly high. The income so earned through taxation should be spent on providing various types of facilities, subsidies and amenities to the poorer section of the community. For example, the state can extend to the poor benefits of old age pensions, social insurance, free medical aid, cheap housing, interest-free loans, subsidized food etc. This will automatically bring redistribution of wealth (national income) in favour of the poorer section of the community. On the contrary, public expenditure which confers larger benefits to the richer sections of the community, e.g., subsidies on luxury goods, provision of subsidized milk, other foodstuff etc. tends to widen the gap of inequalities. As Dalton puts, “That system of public expenditure is best which has the strongest tendency to reduce inequalities of income”. Public expenditure has, thus, an important role in reducing economic inequalities in the community.

(Old Course)

Full Marks: 80

Pass Marks: 32

Time: 3 hours

1. (a) Fill in the blanks:                   1x4=4

1) Public finance is a study of income and expenditure of a _______.

2) Financial _______ possess the expert knowledge in financial matters.

3) _______ is the major source of public revenue.

4) _______ developed the theory of ‘Ability to Pay’.

(b) Answer the following questions:                   1x4=4

1) Write the name of a merit good.

2) Mention one canon of taxation.

3) Mention any one source of internal public debt of the Government of India.

4) Mention one example of developmental expenditure of a State in India.

2. Write short notes on:                4x4=16

a) Role of Public Finance.

b) Techniques of Budgeting.

c) Non-tax Revenue.

d) Deficit Financing.

3. (a) Discuss the importance of public finance in modern times. Also distinguish between public finance and private finance.      7+5=12

Or

(b) Explain the theory of ‘principle of maximum social advantage’ with the help of diagram. State its practical problems. 8+4=12

4. (a) State and explain Adam Smith’s canon of taxation.        11

Or

(b) What is financial administration? Briefly analyze the principles of financial administration. 2+9=11

5. (a) Define taxation. Mention the effects of taxation on production and distribution.   3+8=11

Or

(b) Describe various sources of public revenue. What in your opinion can be the best classification of the sources of public revenue?                            8+3=11

6. (a) Discuss about the various aims and objectives of public expenditure as classified by Prof. Dalton. Mention about the effects of public expenditure on production and distribution.     4+4+3=11

Or

(b) Explain the significance of public expenditure on the economic development and economic stability of our country. 11

7. (a) Discuss the impact of public debt on a developing country. Describe the various methods of repayment of public debt.     5+6=11

Or

(b) Explain the following:                          5.5 + 5.5 = 11

1) Municipal Corporation.

2) Gram Panchayat.

***

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